Tilting the Balance in the Se ller’s Favor

A soft m&a market, tight credit, and corporate aution – key ingredients of a “buyer’s market” – have given acquirers the edge in virtually every aspect of the deal process today. This kind of environment provides more room for buyers to be choosey in selecting targets and meticulous in scrutinizing potential acquisition candidates. The negotiating postures of buyers and sellers and the pressures that weigh on the parties have changed dramatically in the past several years. With the increased scrutiny of companies’ accounting and other business practices, buyers, understandably, are focusing more attention than ever on due diligence. Sellers, even though they seem to have come to terms with today’s lower valuations, still want to make sure that they get a fair price for their assets. While both sides had almost equal negotiating power in hammering out deals a few years ago, current market conditions now give the upper hand to the buyers, who enjoy increased leverage throughout the sale process, especially during due diligence. During that phase of the deal process, sellers are often operating in a defensive position against buyers who are running a fine-tooth comb over the business and demanding information and answers. But sellers don’t have to play the role of the underdog during due diligence, deal experts say. Savvy sellers can use sophisticated diligence techniques to gain some leverage at the bargaining table. By proactively managing the due diligence process, providing potential acquirers with quality information, and moving with deliberate speed, sellers can gain more control over the diligence process, says Curt Cornwell, a partner in the transaction services group at PricewaterhouseCoopers. The only way a seller can keep from losing out in a buyer’s market, he adds, is to be prepared, to anticipate the buyer’s questions, and to close the deal quickly. “The idea behind sell-side preparation is for a seller to be proactive, so that it is not put in a position of constantly responding to the buyer’s questions. The aim is to disarm the buyer, by anticipating his issues, and thus take away some of his bargaining power,” says Cornwell. “The more control a seller has over the sale process, the more difficult it is for a buyer to take advantage of the seller.” Cornwell believes that in order to secure the most value for a seller, the sale process must be run in a project management style. He and his colleagues at the firm developed a sell-side preparation, or sell-side due diligence, process for their selling clients several years ago – when the market shifted from being a seller’s market to being a buyer’s market – so that they could gain more control over the sale process. Effective project management of the sale of a company or division, Cornwell says, includes the following elements: * Planning and preparing adequately before the sale process begins in order to avoid any “surprises”; * Providing all parties involved in the transaction with the quality information they require, including financials and performance metrics; * Moving swiftly to close the deal as quickly as possible; and * Minimizing disruption to the company’s or the division’s performance during the process. In the pre-sale preparation phase, the seller should take a long, hard look at the business being sold so that it fully understands the strengths and weaknesses of the company and can present them in the best possible light to a potential buyer. The seller should also establish plans to mitigate every possible issue or concern that is likely to arise during the sale process, says Cornwell. Nobody likes to have “surprises” pop up during the deal process, Cornwell adds, especially potential acquirers. Unearthed liabilities, conflicting information, and vague responses from a seller raise questions about the integrity and the competence of the seller. These questions, Cornwell adds, inevitably translate into lower bids from the buyer, who wants to build in an “uncertainty discount” for any additional issues that might arise after the deal closes. The best way to ensure that there are no surprises in the first place is to carefully plan and prepare for a sale before putting the company on the block. Ben Buettel, a managing director in the Chicago office of Houlihan Lokey Howard & Zukin, likens this planning to the preparation a job applicant does before taking an interview. “You have to have your story down, just like you would for an interview, because if you are not confident about what you are saying and are over-apologizing for any negative aspects of the company’s performance, potential buyers might think that there is something even more wrong with the company than what the seller is telling them,” he says. Another important element of pre-sale prep work is for the seller to establish a formal procedure for responding to all of a potential buyer’s questions and requests, says Douglas Hubert, a managing director at Century Capital Group. “The seller should appoint a lead person to coordinate all the information that a buyer might need and provide responses to all questions. Having that done through one person is important in order to avoid providing any inconsistent information. Consistency, especially during the due diligence process, is critical,” he states. The preparation phase of the sell-side due diligence process, says Mark Ross, a partner in the transaction services group at PricewaterhouseCoopers, was created for clients who “were getting beaten up” by buyers looking at their business and raising issues that should have been dealt with before those buyers ever got in for a look at the company. Today, many companies are facing liquidity problems and are being forced to sell pieces of their business – in many cases, troubled pieces of their business. They are realizing that the only way they are going to achieve their desired value for their business is by understanding it better than prospective buyers and coming to the bargaining table fully prepared. Buettel backs up this point, stating, “People are spending a lot more time looking at minutia than they were three or four years ago, when the market was in its heyday. Today there are more reasons to scrutinize a potential target, more reasons to pay less for it, and more reasons not to buy at all. Being prepared may help a seller minimize the number of reasons people have to try to haircut the value during the sale process.” Next the seller should arm itself with key pieces of data that would be of interest to a buyer. Generally, these data will include key performance metrics and operating statistics, says Cornwell. It is critical for the seller to anticipate the points that a prospective buyer would want to focus on, he notes. “If you’re a public company, you should stand in the shoes of analysts, shareholders, and potential buyers of both the stock and assets and determine what information would be valuable to them in terms of making decisions on whether to buy, hold, or sell the stock, or to buy the assets,” he says. Sample financial data points for a company, according to Ross, could include sales by product line, margin by product line, etc. – statistics with a bit more “depth” to them than macro financial metrics, such as EBIT and sales at the top-line level. “The idea is to highlight key performance and operating statistics and the function they play in helping to tell the company’s story. From the seller’s perspective, you can put as many financial metrics as you want in front of a buyer, but if you don’t have a good operating story and the empirical data to support it, the sale becomes an uphill battle,” he says. Ideally, Cornwell notes, companies should track these key performance metrics with an internal performance measurement and management system, whether or not a sale is impending, as part of the normal course of doing business. “That way, it becomes much easier, in the event of a sale, to generate not only the financial reports but also the operating statistics to support their story of why the business is worth what they’re saying it’s worth. This rigorous preparation is a fundamental part of what a seller must to do to get the full value from the business being sold.” Meaningful and readily available data will help impress a buyer and speed up the sale process. Additionally, the seller’s performance measurement and management system is an added asset for any buyer, says Cornwell. Sellers that have implemented this system will have procedures in place for supplying information to potential buyers; sellers that cannot provide immediate information will inevitably experience a slower, more thorough due diligence process that could result in value depreciation, he remarks. “When the seller is prepared in advance, it can decide how to deal with any issues it uncovers and can take them out of the value equation. The worst-case scenario is when the buyer uncovers an issue late in the deal process and turns it into a value issue,” says Ross. In addition to being prepared and providing buyers with quality information, deal experts advise that the seller keep the process moving at a rapid pace. Time definitely works in favor of the buyer, especially during the due diligence process, they note. Speed is important because it reduces the chance that events, either within the company or outside of the company, can disrupt the process or reduce the value of the business being sold. Seller preparation goes a long way in helping the process to move along swiftly, says Cornwell. If the seller provides the buyer with a package of organized, high-quality data, the buyer can quickly sift through it. If the seller were to throw a bunch of numbers, facts, and statistics at the buyer, it would take much longer for the buyer to sort through and make sense of the information – and that would lengthen the deal process. Up front seller preparedness results in a much more streamlined, focused process that eliminates a lot of the back-and-forth exchanges of questions and answers between the parties. Studies have shown that the longer the due diligence process lasts, the more the purchase price tends to be reduced from the preliminary indication of the value that the buyer provided to the seller early in the process, says Cornwell. “If you’re a public company, the last thing a seller wants is to have the sale slowed down and to have to slink back to the board with a disappointment regarding price based on a weakness that the buyer has uncovered,” he says. The key is to close as quickly as possible to reduce the risk of not closing the deal at all or of having to provide price concessions, and to minimize the disturbances on the business, he says. And the longer that the sale process drags on, the more it affects the underlying performance of the business being sold, says Ross. He says he has seen numerous situations in which management’s performance has deteriorated because they were focused on trying to sell the business rather than run it. Compounding the problem is the fact that when managers know that a business is being sold, their performance can begin to slip as they spend more time worrying about the fate of their jobs. The streamlined process allows the seller to shorten the amount of time that managers need to dedicate to the sale, and that minimizes disruption to the business’s performance and helps preserve deal value. Due diligence can set the terms of the sale and give an edge to the team that has done its homework, says Cornwell. By following this sell-side preparation process, a seller can reap true economic benefits by avoiding value deterioration during due diligence, and in some cases can even increase value through a well thought-out presentation of the company’s financial and operational information. The benefit to the buyer is a more straightforward and quicker due diligence process that keeps it from wasting a lot of time on the deal.